The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Monday, May 27, 2013

Paul Krugman on "Japan the Model"

In his New York Times' column, Professor Paul Krugman looks at Japan's pursuit of aggressive monetary policy combined with a dose of fiscal stimulus as the model for ending what he sees as the lack of effort by policymakers to fix the global economy.

So the overall verdict on Japan’s effort to turn its economy around is so far, so good. And let’s hope that this verdict both stands and strengthens over time.

For if Abenomics works, it will serve a dual purpose, giving Japan itself a much-needed boost and the rest of us an even more-needed antidote to policy lethargy.

As I said at the beginning, at this point the Western world has seemingly succumbed to a severe case of economic defeatism; we’re not even trying to solve our problems. That needs to change — and maybe, just maybe, Japan can be the instrument of that change.

Please re-read Professor Krugman's comments as he has identified a critical problem: "we're not even trying to solve our problems."

The reason that we are no longer trying to solve our problems is that it means acknowledging what has been done so far did not fix the economic problems.

And this opens up Pandora's Box for policymakers who have adopted the Japanese Model and chosen to protect bank book capital levels and banker bonuses at all costs.

It opens up Pandora's Box because it is clear that the combinations of austerity/monetary stimulus and fiscal stimulus/monetary stimulus have both failed. As Professor Joseph Stiglitz said in a Bloomberg article,

“Clearly the economy is not back to normal, and to accept this as the new normal would be really wrong.”

Regular readers know that there is a proven solution for ending a bank solvency led financial crisis like the crisis we are currently experiencing. That solution is the Swedish Model.

Under the Swedish Model, banks are required to recognize upfront their losses on the excess public and private debt in the financial system. This removes from the real economy the burden of servicing the excess debt and ends the diversion of capital that is needed for reinvestment, growth and to support the social programs.

Since the 1930s when the US first implemented the Swedish Model, banks have been designed to absorb the losses on the excess debt and continue to operate and support the real economy. Banks can do this because of the combination of deposit insurance and access to central bank funding.

With deposit insurance, taxpayers are effectively the banks silent equity partner when the banks have low or negative book capital levels. Capital levels that can be rebuilt over several years through retention of 100% of pre-banker bonus earnings.

As Professor Krugman rightly points out, we are not trying to solve our economic problem. In fact, this is a choice of the policymakers under advice from the bankers.

After all, the bankers stand to lose their cash bonuses if we fix the excess debt problem with the economy.

So long as policymakers don't try to solve our economic problems, the bankers benefit and it is society that bears the costs.

As your humble blogger has said since the beginning of the financial crisis, the question is "When" will policymakers put their countrymen ahead of the bankers?

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.